Keeping investors up to date on macro economic affairs, so they can make informed investment decisions. This blog also has a focus on discussing the interaction between macro economics and cultural affairs.

Wednesday, February 9, 2011

Project Merlin

The UK Government is expected to announce the results of the 'project' to make a deal with the banking sector over bonuses and lending. The public relations people have obviously been busy this morning because the details are being leaked all over the press.

According to press sources, the deal will involve the banks agreeing to lend $190bn to business, whilst agreeing to pay lower bonuses for 2010 than in 2009. Furthermore, the banks will be forced to disclose the pay of the top 5-10 earning executives as well as the most senior executives on the board.

This comes after the Government had increased the bank levy, raising £800m in tax revenue. Whilst the levy is seen as raising £2.5bn this year, the latest changes are believed to result in a net tax cut to the banks due to the cut in corporation tax from 28% to 24%

Thoughts on Project Merlin

Frankly, I think this is a largely cosmetic move. It does not deal with any of the fundamental issues and represents a 'fob off' to the taxpayer. It deals with none of the problems of the crisis as brilliantly articulated by Mervyn King in this link here

Firstly, the deal over disclosure of the pay of the top earners is largely a move to allow the press to focus on what the top earners are pulling in. Whilst this will help the media sell newspapers, it will not deal with the fundamental incentive issues that caused the financial crises. What marginal difference will it make to the strategy of Barclays if Bob Diamond* is forced (via press pressure) to take a bonus of , say £7m, from the £9m he is believed to be earning this year?

Moreover, what difference will it make to the banks risk management policies will it make, if the top five earners have to disclose their salaries? As for disclosure over the senior executives on the board, I should remind readers that, by UK law, anyone is entitled to walk into a publicly listed company and immediately, be granted details over directors pay.

Secondly, this 'deal' essentially represents confirmation that the banks really are just gaming the taxpayers with the tacit collusion of the politicians. The proper role of the banks is to lend capital on the back of assets and, earn a small cut in the process. That is their job. However, this negotiation sees them horse trading over lending money British business in order to being given an easy ride of bonuses.

Is it worth reminding readers that the point of taxpayers bailing out the banks was to ensure lending in the UK economy? The bankers seem to think it was in order to secure their salaries.

Finally, the banks are expected to pay out £6-7bn this year in bonus. Whilst this is scandalous in itself, it does not include an estimate for the hikes in salary that they awarded themselves last year, in order to get around the bonus tax. Furthermore, it is confirmation that nothing has changed with regard the incentive structure that created the mess in the first place.

What is uniquely insidious in this is that the UK Government probably wants the bankers to get the bonus because they still think that the best way to get tax revenue is to encourage the UK financial services industry to resume their pre-eminent position. Furthermore, as the industry makes up 14% of GDP, these huge bonuses will encourage a few billion into the London housing market.

UK Economy , Housing, and Bankers Bonuses

Now, let's put the facts together. The latest RICS housing market survey indicates that supply of housing for sale is not forthcoming in the UK market. Similarly, demand is low as a consequence of buyers being unable to get funding, because unemployment is high and banks aren't lending. All of which, isn't particularly positive for the UK economy due to the high correlation of the economy with the 'wealth effect' of high house prices.

Solution? Let's continue to redistribute resources towards the banking sector in order to shore up the London housing market and spur consumer spending. In other words, mop up the aftermath of the crisis by germinating the conditions that caused it in the first place.

*It is worth reminding readers of the track record of this man, who delights in telling UK parliamentary committees that it is time for the banks to stop 'apologising' for the crisis. Bob Diamond was involved in Barclays trying to outbid RBS for ABN Amro and, despite any press spin, there is no public record of him opposing the attempted purchase.